A Qualified Opportunity Fund (QOF) is an investment vehicle designed to encourage long-term investments in economically distressed communities, known as Opportunity Zones. Created under the Tax Cuts and Jobs Act of 2017, QOFs offer investors tax incentives to support development and growth in these designated areas. Here’s a breakdown of how a QOF works:
- Opportunity Zones designation: Local governments nominate specific census tracts as Opportunity Zones, which are then certified by the U.S. Department of the Treasury. These zones are typically low-income or economically underdeveloped areas that could benefit from increased investment.
- QOF formation: A QOF is formed as a corporation or partnership with the primary purpose of investing in eligible property or businesses within an Opportunity Zone. At least 90% of the QOF’s assets must be invested in these qualifying investments.
- Investor participation: Investors can contribute capital gains from the sale of property or assets to a QOF within 180 days of realizing the gain. These funds are then used by the QOF to invest in eligible projects or businesses within Opportunity Zones.
- Tax incentives: Investors who participate in a QOF are eligible for various tax benefits, including:
- Deferral of capital gains tax: The capital gains tax on the invested amount is deferred until the investment is sold, or until December 31, 2026, whichever comes first.
- Step-up in basis: If the QOF investment is held for at least five years, the investor receives a 10% increase in the basis of the deferred gain, effectively reducing the capital gains tax. If held for seven years, the basis increases by an additional 5%, totaling a 15% reduction in the capital gains tax.
- Tax-free growth: If the QOF investment is held for at least ten years, any appreciation in the value of the QOF investment becomes tax-free when sold or exchanged.
- Investment in Opportunity Zones: The QOF uses the invested capital to finance projects, such as real estate development, infrastructure improvements, or business expansion, in the designated Opportunity Zones. These investments are intended to spur economic growth, create jobs, and improve the quality of life for residents in those areas.
In summary, a QOF works by pooling investments from individuals with capital gains and directing those funds into projects within economically distressed communities. In return for their investment, investors receive significant tax incentives, while the Opportunity Zones benefit from increased economic activity and development.